By: Staff Writer
August 10, Colombo (LNW): Sri Lanka’s private sector credit expanded by an unprecedented Rs. 221 billion in June 2025, the highest monthly increase on record, according to official data. The surge, driven by a rebound in private investment, improved fiscal discipline, and the impact of a recent policy rate cut, has sparked optimism for stronger economic activity — but also renewed caution over potential financial stability risks.
The June expansion surpassed the previous record of Rs. 193 billion in December 2024. While December’s credit jump was largely due to short-term import financing that later reversed, analysts note that the latest rise reflects longer-term investment credit, which tends to sustain import demand and can strain foreign reserves if funded through central bank liquidity instead of real deposits.
Private Sector Leads Borrowing Boom
During the first half of 2025, private borrowings totaled Rs. 700 billion — outpacing central government borrowings (Rs. 178.4 billion) by a staggering Rs. 521 billion. In June alone, the government borrowed Rs. 98.3 billion from banks, reversing a Rs. 53 billion repayment in May, while state enterprises recorded a net repayment of Rs. 1.2 billion. The Central Bank also contracted its own credit by Rs. 51 billion.
The Central Bank’s deflationary stance and a stable exchange rate have been credited with creating a predictable environment for investment. Prices — including for construction materials — have remained stable or declined, boosting disposable incomes and enabling salary increases to be channeled into productive activity. Analysts note that, if the government maintains fiscal restraint and avoids non-priority capital spending, this stability could strengthen tax revenues and reduce budget deficits.
Warnings over ‘Late-Cycle’ Cuts
However, concerns have emerged over the recent policy rate reduction. Economists warn that similar late-cycle cuts in 2012, 2016, 2018, and 2019 — implemented amid a private credit upswing — ultimately triggered balance of payments stress, currency depreciation, increased foreign borrowing, and, in the lead-up to 2022, sovereign default.
June’s rate cut came at a time when banks were raising deposit rates, a move that could have moderated consumption while providing deposit-funded credit for imports. Instead, central bank liquidity injections — including swaps with domestic banks, where past-accumulated dollars are used as collateral — have supported rupee credit expansion. Analysts caution that such measures create contingent liabilities for the Central Bank and may erode net foreign assets if they reduce the Bank’s capacity to purchase dollars outright.
Balancing Growth and Stability
While the credit surge reflects a revival in domestic investment and consumption, analysts stress that this momentum is sustainable only if monetary and fiscal policy remain disciplined. Over-accommodation — described by some as the “dreaded” phase of economic cycles — risks undermining stability, repeating the policy errors that have led to past currency crises.
Bond sales, some argue, offer a safer tool for liquidity management, as interest costs can be rolled over without immediate cashflow strain, unlike private credit expansion funded by excess liquidity. The challenge now lies in ensuring that Sri Lanka’s record credit growth fuels long-term productivity — rather than another cycle of debt, reserve depletion, and economic instability.
